Ratings firms are on track to cut the most US corporate bonds to junk since the early part of the pandemic, further boosting funding costs for some companies just as economic growth is slowing.
(Bloomberg) — Ratings firms are on track to cut the most US corporate bonds to junk since the early part of the pandemic, further boosting funding costs for some companies just as economic growth is slowing.
In the first quarter, a total of $11.4 billion of bonds were downgraded to high yield status, a figure that’s about 60% of 2022’s full-year total, according to Barclays Plc research. Full-year volume is on pace to be the highest since 2020 when the pandemic sparked a massive wave of downgrades, according to the bank’s estimates.
The latest downgrades reflect the pressure that many companies are facing as the Federal Reserve has hiked interest rates at the fastest pace in decades. Borrowing costs are rising across the board, but corporations that see their bond ratings cut to junk face an extra boost in funding expenses because a smaller universe of investors is eligible to buy their bonds.
Barclays expects downgrades to junk status to accelerate in the second half of the year as slowing economic growth puts additional strain on blue-chip borrowers. The bank this year expects between $60 billion and $80 billion of these securities known as fallen angels, according to a note by strategists led by Dominique Toublan.
“A downgrade from investment grade to high yield signals that there is a credit deterioration for that company,” Toublan said in a phone interview. “The question becomes is it just the one company or is it a broader theme?”
The bank looked at bonds that are no longer eligible for the high-grade Bloomberg US Corporate Bond index. For companies rated by three firms, that means they have at least two high-yield ratings.
Even as more companies are getting cut to junk, a growing number of bonds are likely to be upgraded to investment-grade, according to Barclays. The bank expects about $60 billion to $70 billion of these “rising stars” this year, which would be the second highest total on record. The pace of those upgrades is likely to slow in the second half, the bank said.
Nissan, Banks
The lion’s share of the fallen angel total came from Nissan Motor Co. Ltd’s $9.8 billion debt pile, which S&P Global Ratings cut to speculative grade in March. The automaker retains an investment-grade rating from Moody’s Investors Service. Nissan didn’t respond to a request for comment.
But the list of fallen angels also included two regional banks — First Republic Bank and Axos Financial. The firms weren’t immediately available for comment.
SVB Corp.’s debt isn’t included because the parent of Silicon Valley Bank filed for bankruptcy, skipping the junk-bond market and going straight to default. The regulated bank is being taken over by First Citizens BancShares Inc.
While the dollar volume of fallen angels is rising, downgrades are still relatively muted. The $60 billion to $80 billion of downgrades the bank forecasts represent about 2.2% of BBB tier corporate bonds, according to Barclays. The average since 2000 is closer to 6.6%, the bank said.
Tighter Conditions
The collapse of Credit Suisse Group AG as well as regional lenders including Silicon Valley Bank may be cutting into lending. The total loans on banks’ books have declined by about $95 billion since mid-March, according to data from the Federal Reserve. Credit conditions are generally getting tighter, which tends to spur more ratings downgrades.
Declining profits are likely to eat into corporate borrowers’ bottom lines and could hurt margins for issuers more sensitive to changes in the economy, Fitch Ratings wrote in a report Monday. The credit grader’s latest expectation for US real gross domestic product is 1%, down from 2.1% in 2022. Fitch expects a recession to occur late in the third quarter.
“Monetary tightening and slower economic growth will negatively impact demand while easing inflation will reduce pricing power, leading to lower revenue growth and less ability to protect margins, absent cost cutting, for some U.S. companies,” the report said.
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